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EU Buckles, but it will be a tough sell for Germany

EU leaders at a summit in Brussels agreed that euro area rescue funds could be used to stabilize markets (read bail-out countries) without forcing these countries that comply with EU budget rules to adopt extra austerity measures or economic reforms. It was also agreed that a single supervisory body for euro zone banks, housed under the European Central Bank, would be created by year’s end—much faster than previously discussed. In essence, what the EU agreed to, after Spain and Italy withheld their support for previous measures, is to remove any need for austerity measures to qualify for bail-out funds. More to the point, the rules regarding membership in the EU, among them the requirement that countries maintain debt levels not to exceed a maximum of 60% of GDP and budget deficits not to exceed 3% of GDP.

As you probably are aware, most of these troubled countries are running sovereign debt levels at more than twice this ceiling, and budget deficits in the double digits. Countries like Greece completely lied to the EU about their debt levels and budget deficits, until they became so large that the country had to beg for outside assistance (a bailout). The get the bailout, they agreed to austerity measures, including cutting their budget deficit and eventually reducing their national debt as a percentage of GDP. With this new “agreement” these requirements are off the table. In other words, these countries took money and will take even more money from the bailout fund, and will not be required to stop the excessive spending that got them into trouble in the first place.

As I always state: You cannot borrow your way out of debt, which is exactly what these countries are trying to do. They will eventually default, and countries like Germany, which is relatively stronger economically, and which is providing the bulk of the bailout money, will be left holding IOUs that they will never collect on. This will be a tough deal for Angela Merkel to sell to the German people. The positive is that some of the short-term pressure has been alleviated from the financial markets, but the underlying problems remain, and with this agreement, will only get worse in time.

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